In March of 2017, Catasys (CATS) reported their fourth quarter results for 2016. This was an important earnings announcement as it marked the first quarter of the product launching with major health plans, which resulted in a large uptick in enrollments. And, the street took notice. Shares of CATS rallied into and post earnings as investors saw the explosive nature of their business model.
Since then, however, shares have traded downwards until hitting their recent lows about 2 months ago. There were two reasons for the downward trajectory in the stock. First off, after a big Q4 in terms of enrollments, growth stopped. Then, the Company undertook a secondary financing and that really hammered the shares.
In our opinion, these two issues, while valid to have given investors pause, are firmly in the rear-view mirror. The secondary financing, and associated dilution, is now ancient history. The Company is funded and, importantly, management committed substantial personal resources to the transaction.
Meanwhile, CATS’ upcoming earnings call, expected in mid-August, should provide the detail and guidance to help investors realize that the pause in enrollment is now behind the Company and that it’s time to start thinking about the incredible earnings growth potential inherent in this stock.
Why did enrollments slow?
Catasys came out of the gate firing. During Q4 of last year, they were actively working with both Aetna and Humana, two major healthcare providers. As a result of these engagements, the Company had 8,000 eligible members that they could reach out to in the fourth quarter. Based on CATS guidance of 20% enrollment over time, and $6,700 per enrollee, this gave the company the potential to have $10,000,000 or so in annual billings* from these customers.
*On a side note, the Company reports GAAP numbers, but feels that Billings are the best way to judge their current business. Since their customers are all very large insurers, they have limited risk in turning billings into cash revenues and do so on a 30 – 45 day delay consistently.
Catasys operated at, or slightly above, that potential during the 4th quarter, with enrollment up 150% year over year and billings of approximately $2.1M. Catasys looked like it was poised for amazing growth as they strove to broaden their current engagements and bring on other healthcare insurers as customers.
Unfortunately, before this could come to pass, the Company hit a couple speedbumps that temporarily derailed their plans. First off, the failed Aetna & Humana merger threw a major monkey wrench into Catasys’ business with Humana; that company went on a system-wide freeze for all care management programs*.
*Humana shut down Medi-Care care management programs in mid-year 2016 at the time of Aetna merger. When they relaunch with Catasys in September, it will be the only care management program they have active at that time.
Meanwhile, while Humana was shutdown, the Aetna rollout was disrupted by integration issues on their side. Coventry, a client of Catasys’ which had been acquired by Aetna, was working well, but the broader Aetna platform launch had issues which meant that Catasys was only getting 5% of the potential Aetna business. The result of all this was that, overnight, screening and outreach to both of their two largest customers went basically on hold.
This cessation of ability to generate additional outreach to eligible members was reflected in Q1’s earnings wherein CATS’ billings were essentially flat with the fourth quarter of 2016.
This trend of weak billings likely didn’t stop in the second quarter. We expect 2nd quarter numbers to reflect continued softness in business as neither Aetna nor Humana business returned in force during the quarter. This is the bad news. The good news is that the 2nd quarter should mark the low point for Catasys and we, along with the Company, expect to see a dramatic ramp in the back half of 2017.
A stumble out of the gate, but Catasys is getting back up to speed
Looking back at Q4 last year, Catasys had approximately 8,000 eligible members that they were pursuing and from which they managed to get $2.1M in billings. During the next two quarters, the company was virtually on hold as they waited for Humana to start up again and for Aetna’s IT department to get their act together and square away the integration issues. Those were tough quarters.
Looking at the 3rd quarter and beyond, however, the landscape looks dramatically different for Catasys. By my estimation, with Aetna coming on line recently, in the month of July the Company is able to approach in excess of 20,000 eligible members for their program. This number is 2.5X what they were pursuing in Q4 of last year and is just the start as they move towards 65,000 or more eligible members covered by year end.
What is driving this eight-fold increase from outreach to 8,000 eligible members up to 65,000? Here’s a list of the changes that are taking place in real time with regards to Catasys’ customer relationships.
- Aetna is back on line and larger than ever. The integration issues have been fixed and they are expanding coverage to Texas and Massachusetts. At the same time, Catasys has determined that Aetna has 50% more eligible members than had been assumed prior, in every state covered.
- Health Alliance Medical Plan (HAMP) announced a major expansion of their business with CATS.
- Centene has launched in Texas, which is approximately 30% of their total members.
- HCSC may be launching in August…this is the 2nd largest Blue Cross / Blue Shield provider.
- United Healthcare should be launching in August or September.
- Humana should be live again in September.
Looking at the list of customers and the rollout taking place to 2.5X as many eligible members as last year’s Q4, it’s clear that business in the third quarter could be significantly larger than any quarter before. Furthermore, a back of the envelope analysis suggests the Company could exit 2017’s fourth quarter at a run rate as much as 10 times larger than Q4 of last year, which might result in a year end run rate in excess of $20M per quarter.
What to look for in the upcoming conference call…and from the stock.
When Catasys reports their 2nd quarter, we don’t expect to see anything impressive in terms of billings or revenue. The numbers will likely be a small loss and no top line growth. For CATS, it’s all in the internal forecasts which they share with investors.
At the time of the conference call, we will be looking to see how many eligible members they currently have and what their internal expectations are going forward. The ramp is expected to be impressive. We believe they are north of 20,000 at this time and will exit the 3rd quarter with over 30,000 eligible members*. The Company’s target of 65,000 by year-end is a great goal; let’s see if they keep that figure.
*An point to consider when looking at eligible members is the time delay in turning them into patients. When a new customer engages, the eligible member count jumps immediately. However, the outreach has only just begun and, while the company expects to turn 20% of eligible members into patients, conversion does occur over time.
It’s also important to get an update on individual plan rollouts. To date, all plans have added additional states and diseases. Let’s see if that trend continues. Also, guidance regarding the timing of launches at HCSC, Humana and United Healthcare will be important.
Finally, the Company has very aggressive internal growth targets* for 2018 and beyond. Let’s see if they maintain these forecasts, along with their stated goal of being cash flow positive in the first quarter of next year.
*Catasys doesn’t provide guidance, but they do have internal forecasts for planning purposes, and share those forecasts with investors. The Company is expecting billings of $19M in 2017, $57M in 2018 and $145M in 2019. They state frequently that, due to the large size of their clients, timing of business may vary from their forecasts, but that they also believe their numbers to be very conservative relative to the potential market.
From Tailwinds’ perspective, CATS is a must own stock for microcap investors. Catasys has a unique offering that is well protected from competition. Their services provide meaningful IRR to healthcare insurers and positively impact the lives of their patients.
Impressively, Catasys has signed 5 of the 8 largest healthcare companies as customers and are set to bring on two more this year, according to management. This is incredibly impressive as these are not easy clients to win over and speaks to the competitive positioning of CATS. Meanwhile, despite the success they have demonstrated, and the huge potential here, the Company is trading at a very low market cap when compared to forecasts.
It now appears that the issues the Company faced in the first half of 2017 are being overcome in real time. We expect to see the billings and earnings of CATS pick up dramatically starting in the 3rd quarter and going forward. Even if estimates were to come down somewhat (which we don’t expect), the stock is really discounting the majority of the growth. As such, evidence of execution on their plan and maintenance of current forecasts could be huge catalysts for the Company.
At Tailwinds, we have very high hopes for Catasys. However, in a base-case scenario, we believe that simply providing investors with decent forecasts and evidence of execution will cause the shares of CATS to more than double before year-end. Our upside scenario returns a lot more. We own shares in Catasys and will be adding to our position prior to the earnings release.